Shares of the largest U.S. companies continued their outperformance of foreign developed markets during the 3rd quarter. Over the past 12 months, their return also trounced both those of smaller U.S. companies (+4.3% vs. -8.9%) by a surprisingly wide margin.
Below, we show a snapshot of a typical 60/40 portfolio allocation, along with the trailing returns for the relevant index in each asset class. Note: your portfolio's allocation and results may differ—please refer to your Quarterly Portfolio Review Report.
Holding a plain domestic S&P 500 index fund was the winning strategy for the past few years. Giving up diversification would be short-sighted though: as advocated regularly in this blog, equity markets go through cycles. For instance, how many of our readers remember that it was just in 2017 when foreign stocks outperformed U.S. stocks?
We fully expect that today's laggards will be tomorrow's leaders, although we don't claim to be able to predict when "tomorrow" will come. With that in mind, we continue to hold our foreign and small-cap stock funds waiting for diversification to deliver its benefits.
Bristlecone Large Cap Value Portfolio
(Not all clients of Bristlecone are invested in our Large Cap Value Equity portfolio strategy, depending on the size of the overall portfolio, and the client's objectives and constraints.)
Something unusual happened in September: there were a few days during which 2019's hottest stocks took a hit (the so-called "glamour" stocks), while the year's most unloved (i.e., "value") stocks went up dramatically. A similar event happened back in June 2017, only for growth stocks to resume their dominance, so it might be too soon to call for the return of value strategies. However, it is not unusual for such events to be the precursor of longer-term changes in market leadership. There are other signs that the elastic band might have finally stretched to its maximum: witness the recent poor performance of some of the technology companies that went public or tried to (Uber, WeWork, etc.) We would not be surprised to see both value and small stocks outperform large-cap growth and technology stocks sooner rather than later. Famous last words!
The average Bristlecone Large Cap Value portfolio underperformed both the S&P 500 and the Morningstar Large Value index for the quarter. Although it has typically outperformed the latter over periods greater than one-year, our average portfolio continues to lag the former. Again, this is mainly due to the dominance of large technology stocks since the end of the financial crisis (note: your portfolio's results may differ—please refer to your Quarterly Portfolio Review Report).
We only made small adjustments to the portfolio during the quarter. We sold our investment in Alcon (ALC), a spin-off from Novartis, the Swiss pharmaceutical company. Alcon is an eye care company that some of you might be familiar with. Although the market value of the shares received by our clients was small, Alcon is a big company ($28 bn in market capitalization). Its revenue and operating earnings growth have been disappointing for the past few years. Improvements might be on the way, but we felt that at the current valuation, a fair amount of good news was already priced in.
We also increased our investment in Hanesbrands (HBI) and made it one of our larger portfolio positions. The company's brands (including Champion) face challenges from competitors but benefit from consumers increasingly wearing activewear apparel every day. The management team has also improved the company's productivity and increased manufacturing efficiencies. The business generates a return above its cost of capital, and we felt that the recent pullback in the stock price was an excellent opportunity to increase our investment. Hanesbrands also has a good track record of returning cash to shareholders through dividends and stock buybacks.
We continue to like the prospects of our investments, and the portfolio trades at a significant discount to our estimate of these companies' values. In other words, we think that we own a collection of quality businesses at an attractive price. This should provide us with above-average returns going forward.
The Impact of Inflation & How to Protect from It
Inflation is not something that most people worry about these days. When we bring up the subject with baby boomers, though, they often remember that in the late 70s and early 80s, annual inflation exceeded 10% for a short period. Are we likely to see a recurrence?
Over the last 100 years or so, inflation has averaged about 3% a year. For the past 20 years, it has been even lower--in the 1.8% to 2.5% range. Still, there have been a few decades when inflation took a significant bite of investment returns.
Inflation is our subject today for 2 reasons: first, even a 2% to 3% inflation rate can seriously impact the purchasing power of your retirement savings; second, higher rates of inflation have historically come as a surprise.
When we broach the subject of inflation with people who just recently retired, most are surprised to hear that even a low 2.5% inflation rate over 20 years will reduce their portfolio's purchasing power by more than 60%! At 2.5% inflation, an item that costs $1,000 today will cost $1,639 in 20 years. At 3% inflation, it would cost $1,806.
The first thing that we recommend when planning your retirement is to delay claiming your benefits from Social Security. Unless you have health issues or other unusual personal circumstances, delaying past your Full Retirement Age (FRA) will provide you with approximately 8% more in income for every year that you delay. Even better, your benefits will increase with inflation through a mechanism called COLA (Cost Of Living Adjustment).
Owning your home can also help. It will protect you against some of the rising costs of housing, a big chunk of retirees' expenses. Real estate investments can also offset housing inflation, via appreciation in property values and/or rising rents.
For most investors but the wealthiest, that won't be enough, though. Growing your investment portfolio over inflation remains critical but entails trade-offs. There are 3 categories of investments that can help:
- Stocks: historically, they have provided returns in excess of inflation over long periods (10, 15 years or longer). An allocation to stocks will help, but it will also increase the volatility of the portfolio, a risk that can be particularly damaging to retirees (see our comments on the subject);
- Commodities and natural resources: their returns tend to track unexpected changes in inflation, but they also frequently produce poor returns during low inflation environments. Nonetheless, a small allocation to commodities and natural resources stocks can provide some insurance if prices were to increase unexpectedly;
- TIPS or Treasury Inflation-Protected securities are bonds issued by the U.S. government. They offer protection against inflation but also have shortcomings: TIPS of longer maturities expose investors to some downside if interest rates rise, a frequent occurrence during periods of higher inflation. TIPS with shorter maturities tend to have a meager return—if any-over inflation.
Our strategy to offset the long-term risks from inflation starts with a minimum allocation to stocks (adjusted for the client's time horizon and personal situation). It also involves owning TIPS, real estate funds, and natural resources. Building such a portfolio can be a drag on portfolio performance at times of low inflation. Our goal, though, is not to build a ship that can sail fast under a light tail wind, but one that can survive foul weather and make it safely to the other shore.
Although the purpose of these quarterly commentaries is to keep you apprised of recent events and activity in your portfolio, it can also result in a short-term focus that can also be counterproductive.
We pride ourselves in our ability to remain even-tempered in the face of capricious markets to make better decisions. We are always happy to share the reasons supporting our patience and discipline. Think long term!
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At Bristlecone Value Partners our investment decisions are driven by independent thinking and a solid foundation of research. We think of our clients as investment partners and are firm believers in eating our own cooking.
One of Bristlecone Value Partners’ principles is to communicate frequently, openly and honestly. We believe that our clients benefit from understanding our investment philosophy and process. Our views and opinions regarding investment prospects are "forward looking statements," which may or may not be accurate over the long term. While we believe we have a reasonable basis for our appraisals, and we have confidence in our opinions, actual results may differ materially from those we anticipate. Information provided in this blog should not be considered as a recommendation to purchase or sell any particular security. You can identify forward looking statements by words like "believe," "expect," "anticipate," or similar expressions when discussing particular portfolio holdings. We cannot assure future results and achievements. You should not place undue reliance on forward looking statements, which speak only as of the date of the blog entry. We disclaim any obligation to update or alter any forward-looking statements, whether as a result of new information, future events, or otherwise. Our comments are intended to reflect trading activity in a mature, unrestricted portfolio and might not be representative of actual activity in all portfolios. Portfolio holdings are subject to change without notice. Current and future performance may be lower or higher than the performance quoted in this blog.
References to indexes and benchmarks are hypothetical illustrations of aggregate returns and do not reflect the performance of any actual investment. Investors cannot invest in an index and returns do not reflect the deduction of advisory fees or other trading expenses. There can be no assurance that current investments will be profitable. Actual realized returns will depend on, among other factors, the value of assets and market conditions at the time of disposition, any related transaction costs, and the timing of the purchase.
Economic factors, market conditions, and investment strategies will affect the performance of any portfolio and there can be no assurance that a portfolio will match or outperform any particular index or benchmark. Past Performance is not indicative of future results. All investment strategies have the potential for profit or loss; changes in investment strategies, contributions or withdrawals may materially alter the performance and results of a portfolio. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be suitable or profitable for a client's investment portfolio.